Austerity: Cause and predictable effect

There's a general strike on in Belgium today. The predictable effect of austerity cuts to services and wages.

Davos is not a place where policy gets made or treaties get negotiated, as I wrote last week. If it has a benefit, it is that the World Economic Forum gets a bunch of the one percent in a single place for a concentrated period of time and allows thoughtful commentators an equally undiluted opportunity to assess what they are thinking.

The result this morning is three excellent essays by commentators working in the mainstream press.

At The New York Times, Paul Krugman makes much of a chart published last week by British think tank, National Institute of Economic and Social Research (here, scroll down right column). It shows that the current economic downturn in Britain is now longer than that of the Great Depression, if you measure the length of time it takes to return to pre-downturn economic output.

Krugman rightly takes British Prime Minister David Cameron to task for instituting a policy of austerity that has made a difficult situation much, much worse.

However, I think he is wrong to lump Cameron in with a European "policy elite" pursuing "expansionary austerity." Anyone who remotely follows European affairs knows that Britain - when governed by the Conservatives - is at best an adjunct member of the EU club, even if it pays full dues. It is especially an adjunct on the intellectual front.

Conservative politicians and intellectuals feel much closer to American thinking on a wide range of policy issues. Indeed, the euro zone crisis has, at one level been one drawn out tussle between Anglo-American market analysis of, and action on, the euro, and a continental European view of how to address the problem.

In this blog and other articles I have written for GlobalPost since Cameron formed his coalition I have often cited the differences between British Conservatives and the Republican party. Sanity being the main one. Cameron is willing to raise taxes and maintain a top rate of income tax of 50 percent for example and has slashed military spending along with the welfare state.

But there is one thing that British Tories have in common with their American counterparts: a desire to use the debt crisis "to starve the beast."

My guess is that the extraordinarily well-educated Oxford grads who make up Cameron's inner circle appreciate Professor Krugman's Keynes'ian arguments about austerity. But most of them grew up ardent Thatcherites. This is a crisis too good to waste if your goal is to shrink the state permanently.

Luckily, or unluckily, depending on your point of view, they are having as much success at turning off the welfare spigot as they are at reducing the deficit. Because, as Dr. K would point out, "expansionary austerity," does not shrink deficits but does expand welfare rolls,

Krugman, however, may have missed a significant shift that has happened in the last 6 weeks. Austerity is no longer the panacea, on the continent at least, as Ambrose Evans-Pritchard points out in this essay at The Daily Telegraph:

"Credit to households and firms shrank by €90bn in December alone. It is the biggest drop in a single month since the launch of the euro, worse than after the Lehman collapse in October 2008 or at any time during the Great Recession.

"One dreads to think what would have happened to Europe’s banking system and to the solvency of Italy and Spain if Mario Draghi had not come to the rescue before Christmas with unlimited three-year funding at 1 percent, against almost any collateral ... "

Pritchard is a right-wing euro skeptic but he understands that if the euro collapses rapidly and in a disorderly fashion it's another Great Depression for real, not just an interesting reading of one key statistic.

He approvingly quotes the IMF's chief economist, Olivier Blanchard, “Decreasing debt is a marathon, not a sprint. Going too fast will kill growth. What is happening in Europe is making things worse."

Blanchard, a Frenchman, is clearly part of the "policy elite" Krugman takes to task. Clearly not every policy maker is barking up that tree.

But enough of them are looking in the wrong place for The Guardian's, economics editor Larry Elliott to be worried. Elliott agrees with Pritchard about the importance of Draghi's action but goes on to liken Davos grandees to people playing a videogame called Global Apocalypse - and playing it badly. After four years they are still stuck on level 1.

" ... blanket austerity is not working," Elliott writes, "what was originally a global response to a global crisis has become a series of national responses to national crises. It means that Europe is treating a three-dimensional problem (growth, banks, public finances) with a one-dimensional fix of deficit reduction."

Elliott points out the problem in the euro zone and Britain and the United States isn't just one of national indebtedness making economies uncompetitive:

"The fundamental issue in the years leading up to the 2007 financial crisis was not the number of US sub-prime mortgages or even the explosion in derivatives; it was the instability caused by one half of the world running massive current account surpluses and the other half running massive current account deficits. What needs to happen now is that the surplus countries accept the need to increase domestic demand, thereby soaking up exports from the debtor countries, resulting in more balanced growth all round."

Rebalancing to growth rather than cutting to growth ... now that's a policy for a globalized world economy. Anyone out there know who can make it a reality?